In praise of the markets

ANNANDALE, Va. (CBS.MW) -- My thought for the day: The financial markets do an awfully impressive job anticipating the future.

I grant you that this thought is not particularly earth shattering. Nor is it especially timely, since the markets have always possessed this remarkable characteristic.

I nevertheless was prompted to devote my column to this subject by last week's trading in a novel futures contract that was a bet on whether CIA chief George Tenet would resign. (The contract trades on a Dublin-based futures exchange known as Intrade.) After declining for a number of weeks, and thus reflecting a lowered probability of his resignation, the contract's price in the last week of May more than tripled on high volume.

When on Thursday it was announced that Tenet had in fact submitted his resignation, Intrade CEO John Delaney responded by saying, "We think our markets accurately reflected the shift in Tenet's retirement probabilities so we weren't surprised by today's announcement."

This isn't the only occasion on which Web-based futures exchanges such as Intrade have acquitted themselves quite well, thank you. For example, a real-money futures exchange run by the University of Iowa, known as the Iowa Electronic Markets, has allowed for betting on the outcome of each presidential election since 1988. Over the past four elections, this exchange's average forecast error has been about half that of the major polling organizations.

The track record of these exchanges has been so good, in fact, that last summer the Pentagon proposed creating a futures market that would focus on various potential terrorist threats. The hope was that trading on this exchange would provide valuable intelligence to the national security agencies.

That proposal never came to fruition, you may recall. But its death came at the hands of political correctness, and had nothing to do with these market's forecasting abilities.

This may be all well and good, you might be thinking, but what does this have to do with your investing strategy?

Plenty. It should serve as a reminder of just how difficult it is to beat the markets.

Consider: The Hulbert Financial Digest is fast approaching its 24th anniversary of tracking investment newsletter performance. Guess how many of the letters the HFD was tracking in mid-1980 have beaten the market over the subsequent 24 years?

The answer: Just three. More than half the 30 or so newsletters that the HFD was tracking then no longer are published; just 14 have survived. And the model portfolios of just three of these 14 have made more money since mid-1980 than the Wilshire 5000 index
SVH, -14.29%

That means that only 10 percent of the newsletters that were on the HFD's original list have made more money for their subscribers than they could have by simply investing in an index fund.

The results are quite similar for mutual funds, by the way, as pointed out to me this week by MarketWatch reader David Herskowitz. He reports that just 12 percent of the equity funds in existence in 1970 are both still around today and have made more money over the past 34 years than would have an index fund.

I do not take these data to mean that the markets can't be beaten, let me hasten to add. I continue to believe not only that it is possible to beat the markets, but that one can improve the odds of doing so by following in the footsteps of those who have good long-term records.

Nonetheless, one should never lose sight of how stiff a competitor the markets really are. Last week's trading in the George Tenet resignation contract should serve as a powerful reminder of that.

Editor's note: The most recent edition of the Hulbert Financial Digest is available by e-mail or regular mail. Highlights this month include:

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